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2 Escrow Contracts in Acquisition Agreements -A form of contingent payment contract, where buyer and seller agree that seller will deposit a fraction of purchase price (usually 12.2% of it) into a treasury account for a certain period of time (usually 17.4 months). -Employed in private firm and subsidiary acquisitions but not used in acquisitions of publicly traded targets. -In our sample, escrow accounts used in 52.1% of all unlisted target deals. -More commonly used in (i) stock purchase acquisitions and (ii) acquisitions of stand-alone targets.

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7 Several implications of the main research hypothesis follow through. Use of Escrow Contracts - Transaction Risk Predictions -Stand-alone targets are likelier to use escrow contract. -Subsidiary targets less likely to use escrow contract. -Larger targets (relative to acquirer) are likelier to use escrow contract. -Targets with dominant shareholders are likelier to use escrow contract (to manage joint & several liability if post-acquisition breach of reps. & warranties). -Stock purchases (as opposed to asset purchases) are likelier to use escrow contract. Hypotheses

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8 Use of Escrow Contracts - Informational Asymmetry Risk Predictions -Different industry acquisitions likelier to use escrow contract. -Targets w/ higher degree of earnings management likelier to use escrow contract. -Targets in industries w/ higher earnings volatility likelier to use escrow contract. -Targets in industries w/ lower analyst coverage likelier to use escrow contract. -Distressed targets (i.e., w/ lower interest coverage) likelier to use escrow contract. Use of Escrow Contracts – Other Risks Predictions -Escrow contracts are used if reverse insurance, in the form of liability cap limitations (or caps) is included (caps are on average 2.4 times escrow size). Hypotheses

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9 Escrow agreements are more common when transaction risk is high, i.e., for: -Stand-alone private targets, targets with dominant shareholders, larger targets (relative to acquirer). -Escrow contract use shortens time-to-complete transaction by 35.5-51.0%.35.5-51.0% Escrow agreements are more common if information asymmetry risk is high, i.e., for: -Targets in cross-industry acquisitions, targets w/ high accruals, targets in industries w/ high earnings volatility or low analyst coverage, targets that are financially constrained. Escrow agreements are more common when other risks may be present, i.e.: -If no reverse insurance in form of liability cap limitations (or caps) is included. Main Findings

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22 Due Diligence Costs Analysis Bidders use escrow accounts to diminish due diligence costs. No direct proxy for such costs. We proxy for due diligence costs by time-to-deal completion. - Due diligence costs proportionate to time-to-deal completion. We find supporting results using litigation propensity.litigation propensity - Due diligence costs may be direct or indirect. - Inexpensive due diligence may result in future losses & litigation. - We can use litigation as another proxy for such costs. Our findings support hypothesis that escrow contracts diminish due diligence costs.

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31 Implications If both bidders & sellers gain on average by using escrow contracts, shouldn’t all unlisted target acquisitions use it? Potential reasons for why these contracts are not used in all deals: -Sellers who are aware of potential misstatements in reps. and warranties. -Discord among target shareholders with respect to including an escrow. -Sellers with urgent need of liquidity (escrows reduce liquidity). Positive association b/n use of escrow contract & bidder acquisition announcement returns does not imply all bidders should use escrow contract.